The shifting trends in hotel ownership have seen a rise in management contracts in recent years, as investors have looked to take a share in trading profits and the global hotel operators have pulled back from ownership.
As the hotel sector becomes a more mainstream investment, so knowledge is growing on the side of the owners, aided by the growth of the third-party management companies, all of which is driving change in contracts.
Elias Hayek, partner, head of global hospitality & leisure, Squire Patton Boggs, told us: “Over the decades we have seen significant change and ever-increasing sophistication in relation to essentially all the substantive provisions in hotel management and franchise contracts; in particular provisions introducing hybrid structures on fees and charges, control provisions, termination rights, capital expenditure obligations, system wide compliance and standards adhesion, liability and indemnity provisions, to name a few.
“Almost every provision has evolved to align with the institutional and structural changes as the brands shifted to ‘asset light’ strategies in the early 2000s to respond to stock market and shareholder demands. This increased focus on the volume of operating and franchise agreements meant greater need to ensure the brands had unfettered discretion to control the operation of the assets they manage and guarantee the long tenure of the individual relationships, since the primary assets of the brand companies became the agreements with the hotel developers, along with the trademarks.”
The days of the boiler plate 25-year contract are now very much over, with each contract calling for negotiation to ensure that both sides are properly aligned to prevent issues deeper into the relationship, as operators look to hold onto their ever-expanding portfolios and owners hold onto and hopefully increase the value of their investment.
Hayek said: “There is a mixed bag of what kind of management contracts there are out there and it depends on how much appetite there is on the part of the brands to deviate from the norm and offer up some of the creative tool kit solutions from their repertoire. For example, if a brand is looking to put its first flag on a luxury hotel in the centre of a European capital city then the bandwidth for flexibility and creativity is large. Less so for a three-star hotel in a secondary location.
“On the far end of the spectrum the brands are willing to put ‘skin in the game’ by offering up some or all of the following: hard money contributions, parent/corporate level guaranteed owner priorities, broader termination provisions against fixed return criteria, ceding control over bank transactions and contract approvals, capex spending limits, and limiting obligations to brand standards compliance and system charges. On the other end of the spectrum the operator will be looking for unfettered ability to operate with limited owner involvement and minor deviations from the standard operator forms.
“When dealing with institutional investors, there are additional issues to consider; particularly for private equity developers with an exit strategy of three to four years, greater care must be taken to ensure that transfer provisions, ownership dilution and non-disturbance agreements meet the timeframes anticipated by the client. There’s a quid pro quo to the agreement with the brand which reasonably will want to ensure that the proposed transferee or shareholder is aligned with the long term objectives of the brand on the property. I’ve never had a deal which didn’t get signed because of that, but there’s a fine line as to what’s palatable.”
The hotel sector has evolved not only to favour branded growth and with it a pullback in ownership by the likes of Hilton and Marriott International, but also changes in development, driven by rising costs and changing consumer demands. Mixed-use developments have grown in popularity, as they provide developers with the chance to raise money up-front and offset costs, but have also increased the complexity of contract negotiations.
Hayek said: “It’s rare these days that a hotel asset is developed stand-alone without being part of a mixed development, with residential, leisure or office components and these elements have evolved over time - there are many questions raised, the least of which is how to arrange the relationships such that there is continuity, even if ownership becomes different from the Hotel asset in the event of a sale. There is an interplay of all the elements from a brand and guest experience. You have to anticipate that all the elements have to work together and consider the potential evolution of the site.
“There are different structures and ownership elements, there are lease concepts in the short and long term, licensing elements over the short and long term, and potential future sales considerations. Add in the special considerations for the residential components and the governance over (and rights of) unit owners, fees collections, standards compliance, and structural maintenance issues, and you have a lot of moving parts that all need to be balanced and arranged to work together.”
A further aspect of the ways in which the sway of power has changed has been the move towards third-party operators, with the likes of Interstate meaning that more flexibility is on offer to the owner, a scenario which has lead to the growth of hybrid lease/management contracts, as well ‘manchises’, which see owners convert management contracts into franchises.
Hayek said: “Third-party operator management of the hotel assets is becoming the favoured approach by owners and developers. Historically the brands have been very reluctant to allow third party operation of hotels under their brands because they feared loss of control over the operating quality and standards of operation; brand-eroding properties can have a ripple effect on the brand elsewhere.
“As they increased their footprint and geographic reach, the brands were required to set up corporate, regional and local operating structures which were very costly and top heavy, which developers and owners were unwilling to pay for. This created the gap now filled by third-party operators.
“There is often a fear expressed by the owner/developer community that the brands will require more spending at the hotel asset level than is required to improve profitability, if they are focused instead at improving the standing of the brand in the market or in general. This has meant that white-label operators with leaner, profit driven structures have an appeal to the owners and developers - presumably because they are not motivated by an over-arching requirement to develop a brand portfolio. Third party managers act like an asset manager, maintaining the bottom line, while the brands take their fee from the top line.”
The relationship between investors, operators and brands is currently a mutually-enthused one, with schisms rare and, as global travel continues to grow, feeding demand, a happy future seems assured. Economists suggest that there may be some looming bumps in the road, however, and we watch with interest to see how the partnerships survive more testing times.